8. From Policy to Regulation

A. Nesvetailova, (2014), Shadow Banking in Academic and Policy Debate, Presentation Brussels, January 24, p. 12.

A. Nesvetailova, (2014), Shadow Banking in Academic and Policy Debate, Presentation Brussels, January 24, p. 19.

See for a chronological overview of that happening: M.B. Aalbers and E. Engelen, (2015), The Political Economy of the Rise, Fall, and Rise again of Securitization, Environment and Planning, Vol. 47, pp. 1597–1600.

See B. Eichengreen, (2014), Hall of Mirrors: The Great Depression, The Great Recession, and the Uses-and Misuses-of History, Oxford University Press, Oxford.

H. Callagha, (2015), Who Cares about Financialization? Self-Reinforcing Feedback, Issue Saliency and Increasing Acquiescence to Market-Enabling Takeover Rules, Socio-Economic Review, Vol. 13, pp. 331–350.

Aalbers and Engelen, Ibid. p. 1602 and D. Bryan and M. Rafferty, (2015), Austerity: The New Army of Savers, p. 37, mimeo.

A. Walks and B. Clifford, (2015), The Political Economy of Mortgage Securitization and the Neoliberalization of Housing Policy in Canada, Environment and Planning A, Vol. 47, Issue 8, pp. 1624–1642.

FSB, (2015), To G20 Finance Ministers and Central Bank Governors. Financial Reforms- Progress on the Work Plan for the Antalya Summit, London, p. 4.

J. Cunliffe, (2015), Market Liquidity and Market-Based Financing, Speech by Sir Jon Cunliffe, Deputy Governor for Financial Stability of the Bank of England, at the British Bankers Association International Banking Conference, London, October 22, 2015, p. 2.

For the sake of accuracy, he details that ‘[t]here are three concepts of liquidity. Monetary liquidity; funding liquidity; and market or asset liquidity. Monetary liquidity captures the looseness of monetary conditions – it is underpinned by the stance of the monetary policy authority. Funding liquidity is the ease with which banks and other non-bank financial intermediaries can raise funding. And market liquidity refers to the ease with which one asset can be traded for another. All three concepts are tightly related.’ J. Cunliffe, (2015), Ibid. p. 3.

J. Cunliffe, (2015), Ibid. pp. 3–4.

J. Cunliffe, (2015), Ibid. pp. 4–5.

J. Cunliffe, (2015), Ibid. pp. 5–6.

D. Fiaschi et al., (2015), The Interrupted Power Law and the Size of Shadow banking, Working Paper, Mimeo.

S. Claessens et al., (2012), Shadow banking: Economics and Policy, IMF Staff Discussion Note SDN/12/12, December 4, Washington DC, p. 29.

See, for example, for the inclusion (or not) of leasing activities in the FSB definition of shadow banking and the response from the leasing industry: LeaseEurope Inside, (2013), Leasing Not a Shadow Banking Activity, Issue Nr. 19, Winter pp. 1–2. I do refrain from the quality of the arguments both ways in this context.

See for an analysis to/from the US shadow banking system: L. Errico et al., (2014), Mapping the Shadow Banking System Through a Global Flow of Funds Analysis, IMF Working Paper, WP/14/10, January, Washington D.C.

See also R. Jovovic and N. Jovovic, (2013), Understanding Shadow banking and its Role in the Recent Financial Crisis, Working Paper, February 24, mimeo.

P. Tucker, (2012), Shadow Banking: Thoughts for a Possible Policy Agenda, Speech given by Paul Tucker, Deputy Governor Financial Stability, Member of the Monetary Policy Committee and Member of the Financial Policy Committee, p. 2.

T.M. Hoenig and C.S. Morris, Restructuring the Banking System to Improve Safety and Soundness, Working paper, mimeo, pp. 2, 3–5, 20–29 (also published in 2013 in The Social Value of the Financial Sector, Too Big to fail or Just too Big, Eds. V.V. Acharya, T. Beck, D.D. Evanoff, G.G. Kaufman ad R. Portes, World Scientific Studies in International Economics Vol. 29, pp. 401–425).

‘Safe assets’ is a catch-all term to describe such contracts, which may include government debt, bank deposits, AAA-rated corporate debt and asset-backed securities, among others. The International Monetary Fund estimated potential safe assets at more than $114 trillion worldwide in 2011, more than seven times the US economic output that year.

Also the question why the supply of safe assets to GDP has stayed constant stays largely unexplained. We do know however from analysis that the demand for safe assets has been one of the drivers behind the emergence of the shadow banking sector.

See for an excellent review of the ‘safe asset’ infrastructure, conditionalities and post-crisis reflections: A. Gelpern and E.F. Gerding, (2015), Inside Safe Assets, Georgetown law School Working Paper, draft, September 2. They further highlight sources of instability and distortion in the legal architecture, and the political commitments embedded in it (pp. 38–44). See also R. Portes, (2013), The Safe Asset meme, Presentation, October 8; C. Bertaut et al., (2013), The Replacement of Safe Assets: Evidence from the U.S. Bond Portfolio, Working paper, Mimeo; P.-O. Gourinchas and O. Jeanne, (2012), Global Safe Assets, Paper prepared for the XI BIS Annual Conference held in Lucerne, June 20–21; IMF, (2012), Global Financial Stability Report, Chapter 3: Safe Assets: Financial System Cornerstone, pp. 81–122; G. Gorton and G. Ordoňez, (2013), The Supply and Demand of Safe Assets, Working paper, August, Mimeo.

A. Gelpern and E.F. Gerding, (2015), Ibid. pp. 39–40.

Ibid. p. 49.

R.J. Barro an A. Mollerus, (2014), Safe Assets, NBER Working Paper Nr. 20652, October.

M. Brunnermeyer and V. Haddad, (2014), Safe Assets, NYFed Research Paper, October 17. The fact that during the last two decades safe US assets have been in high demand by foreign buyers only aggravates the situation, see J. Vavilukis et al., (2014), Foreign Ownership of U.S. Safe Assets,: Good or Bad?, Working Paper, mimeo, September 8.

See R.J. Caballero and E. Farhi, (2015), On the Role of Safe Asset Shortages in Secular Stagnation, in Secular Stagnation: Facts, Causes and Cures (eds. C. Teuings and R. Baldwin), CEPR Press, London, pp. 111–121.

See for a recent overview of literature on the matter: P. Golec and E. Perotti, Safe Asset Demand: A Review, Risk and Macro Finance Working Paper Series Nr. 2015-02, University of Amsterdam.

C.-H. Weymuller, (2013), Banks as Safety Multipliers: A Theory of Safe Asset Creation, Harvard University, Working Paper, mimeo. See also D. Andolfato and S. Williamson, (2015), Scarcity of Safe Assets, Inflation and the Policy Trap, Federal Reserve Bank of St. Louis, Working Paper, January 23 and the reporting: H.M. Ennis, (2015), Discussion on Scarcity of Safe Assets, Inflation and the Policy Trap by Andolfatto and Williamson, Federal Reserve of Richmond, Working Paper Nr. 15/03.

He also concludes ‘as for asset pricing, the spread between public debt yield and private debt yield reveals bank leverage and can be used as a macro-prudential tool. In an open economy environment, sovereign risk hurts aggregate private leverage but domestic banks become the natural holders of domestic public debt.’

P. Benigno and S. Nisticò, (2013), Safe Assets, Liquidity and Monetary Policy, Working paper, mimeo.

See, for example, B.S. Kay and M. Eden, (2015), Safe Assets as Commodity Money, Working paper, Mimeo, October 8.

P.A. McCulley, (2007), Teton Reflections, Global Central Bank Focus Series, PIMCO, August/September, pp. 1–4. See also B.J. Noeth, and S. Rajdeep, (2011), Is Shadow Banking Really Banking? The Regional Economist October, pp. 8–13.

I. C. Laczano, (2013), The Historical Role of the European Shadow Banking System in the Development and Evolution of our Monetary Institutions, Cityperc Working Paper Series, Nr. 2013/5, pp. 7–8. The other is the Gurney Panic of 1866, see pp. 7–8.

I. Wallerstein, (1976), The Modern World-System. Capitalist Agriculture and the European World-Economy in the Sixteenth Century, Academic Press New York, NY, pp. 229–230.

Laczano, (2013), Ibid. p. 3.

See (1) S. Quinn and W. Roberds, (2012), Responding to a Shadow Banking Crisis: The Lessons of 1763. Federal Reserve Bank of Atlanta. Working Paper Series Nr. 8, and (2) M. Frandreu and S. Ugolini, (2011), Where It All Began: Lending of Last Resort and the Bank of England During the Overend, Gurney Panic of 1866. EHES Working Papers in Economic History Nr. 7. Quinn and Roberds demonstrate that ‘the 1763 crisis was manifested in a loss of liquidity of acceptance loans, a form of securitized credit resembling modern asset-backed commercial paper. The crisis began with the failure of a major securitizer (“conduit”) in Amsterdam, and quickly spread to neighboring markets. The central bank at the hub of the crisis, the Bank of Amsterdam, responded by broadening the range of acceptable collateral for its repo transactions’. Using archival data on the Bank’s operations, they show (1) that the 1763 crisis was proportionately more severe than that experienced in 2008, (2) the Bank’s emergency liquidity infusion likely prevented the failure of two other major securitizers and provided indirect benefits to other market participants. While the underlying themes seem to have changed little in 250 years, the modest scope of the 1763 liquidity intervention, together with the lightly regulated nature of the eighteenth-century financial landscape, provided some informative contrasts with events of late 2008.

See for the wider historical dimensions of money creation and financial innovation which go as far back as 600 BC, Laczano, (2013), Ibid. pp. 4–5.

Laczano, (2013), Ibid. p. 5. It also allowed nimble market players to increase leverage in buoyant financial markets and amass rapid gains at the expense of increased fragility of the system, see Schnabel and Shin, (2004), Ibid. p. 2.

Laczano, (2013), Ibid. pp. 8–10; see also ECB, (2012), Virtual Currency Schemes, ECB Report, Frankfurt.

P. Radovanović, Predrag, (2009), Digital Economy, Digital Money and Digital Banking. Economics and Organization, Vol. 6, Issue 2, pp. 153–160.

See extensively on this topic: E.F. Gerding, (2013), Law, Bubbles and Financial Regulation, Routledge, London and New York, pp. 236–311.

Tanya Beder, (2011), The History of Financial Engineering from Inception to Today, in Financial Engineering: the Evolution of a Profession, T. S. Beder & C. M. Marshall (eds.), Wiley & Sons, Hoboken, pp. 3–28.

E. G. Corrigan, (1982), Are Banks Special?, in FED Reserve Bank of Minneapolis, Annual Report 1982.

E.F. Gerding, (2013), Law, Bubbles and Financial Regulation, Routledge, London and New York, pp. 365–394.

J. F. Houston et al., (2012), Regulatory Arbitrage and International Bank Flows. The Journal of Finance, Vol. 67, Issue 5, pp. 1845–1895.

E.F. Gerding, (2013), Law, Bubbles and Financial Regulation, Routledge, London and New York, pp. 311–336.

See extensively: E.F. Gerding, (2013), Law, Bubbles and Financial Regulation, Routledge, London and New York, pp. 395–470.

See in detail: L. Schwarcz, (1994), The Alchemy of Asset Securitization, Stanford Journal of law, Business and Finance, Vol. 1, pp. 133–154; K. C. Kettering, (2008), Securitization and Its Discontents: the Dynamics of Financial Product Development, 29 Cardozo Law Review, Vol. 29, Issue 1, 1553–1728; R. F. Schwartz, (2007), Risk Distribution in the Capital Markets: Credit Default Swaps, Insurance and a Theory of Demarcation, 12 Fordham Journal of Corporate and Financial Law, Vol. 29, Issue 167, pp. 181–88; M. T. Henderson, (2009), Credit Derivatives are not “Insurance,” Connecticut Insurance Law Journal, Vol. 16, Issue 1, pp. 1–60.

It must be admitted though that commercial banks seem to have a higher default ratio on their underwritten securities than investment banks, see D. Focarelli, (2011), Are Universal banks Better Underwriters. Evidence from the Last days of the Glass-Steagall Act, ECB Working Papers Nr. 1287. This evidence is stronger in the case of ex ante riskier and more competitive issues, and during the first years of bank securities’ subsidiaries’ entry into the market. Based on their results, it is not possible to reject that the repeal of the Glass-Steagall led to looser credit screening by broad (universal) banking companies trying to gain market share and/or to the lower initial ability of these banks to correctly evaluate default risk.

A. E. Wilmarth, Jr., (2009), The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis, Connecticut Law Review, Vol. 41, Issue 4, pp. 963–1050; Y. Nersisyan, (2015), The Repeal of the Glass-Steagall Act and the Federal Reserve’s Extraordinary Intervention during the Global Financial Crisis, Levy Economics Institute, Working Paper Nr. 829.

A.E. Wilmarth Jr., (2014), Citigroup’s Unfortunate History of Managerial and Regulatory Failures, Journal of Banking Regulation Vol. 15, Issue 3/4, pp. 235–265; A.E. Wilmarth Jr., (2011), The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-to-Fail Problem, Oregon Law Review, Vol. 89, pp. 951–1057.

E. Engelen, (2015), TTIP and the Politics of Economic Modeling, blogspot April 26.

F. De Ville & G. Siles-Brügge, (2015), The Transatlantic Trade and Investment Partnership and the Role of Computable General Equilibrium Modelling: An Exercise in ‘Managing Fictional Expectations’, to be published in New Political Economy, Vol. 20, Issue 5, pp. 653–678.

A. J. Pollock, (2014), Can Banks Resist the Real Estate Temptation?, Housing Finance International, Winter, p. 12.

A. Antoniades, (2015), Commercial Bank Failures during the Great Recession: the Real (Estate) Story, ECB Working Paper Series, Nr. 1779, April, Frankfurt. He works with three types of exposures of banks to real estate (a) illiquid assets, (b) marketable securities and (c) off-balance sheet credit line portfolios. He further concluded that the accumulation of real estate risk was larger the larger the size of the bank analysed. Particularly interesting further is that he has no evidence that holdings of traditional home mortgage loans or of agency-issued MBS contributed more to bank failures than exposures to non-real estate loans and non-MBS securities did. The estimates indicate that the primary drivers of failure were exposure to loans and commitments issued to non-household real estate borrowers. The relationship between the exposure to real estate and the later failure of the FI builds along two lines: (a) failed banks invested more heavily in real estate products that performed uniformly poorly across both failed and survivor banks during the crisis (systematic component) and (b) within each of the potentially toxic product categories failed banks invested in assets of lower quality than survivor banks did (idiosyncratic component).

See L. Fink, (2015), The Effects of Short-Termism, Letter to all S&P 500 CEOs, April. Repeated by Fink in 2018 with a new letter on how companies must have a social purpose and pursue a strategy for achieving long-term growth.

Over half of the slowdown in advanced-economy export growth since 2011 (relative to the pre-crisis trend) can be explained by weak global demand growth. More specifically, exports in advanced economies have been restrained by the weakness of global investment, a trade-intensive demand component and weak demand out of Europe, a region that accounts for about 40% of the demand for advanced-economy exports. See in detail: L. Morel, (2015), Sluggish Exports in Advanced Economies: How Much Is Due to Demand?, Bank of Canada/Banque de Canada, Working Papers Nr. 2015-3, March.

P.J. Wallison, (2015), The Regulators’ War on Shadow Banking, AEI Research, January, p. 6.

M. Mazzucato and C.C.R. Penna, (2015), Beyond Market Failures: The Market Creating and Shaping Roles of State Investment Banks, Levy Economics Institute, Working Paper Nr. 831, January.

S. Sen and Z. DasGupta, (2015), Financialization and Corporate Investments: The Indian Case, Levy Economics Institute Working Paper, Nr, 828, January.

See, for example, J. Ewing, (2015), Deutsche Bank to Shed Postbank Branch Network, NY Times, Dealbook, April 25.

Ultra-low or negative interest rates: what they mean for financial stability and growth. Remarks by H. Hannoun, Deputy General Manager, Bank for International Settlements, at the Eurofi High-Level Seminar, Riga, April 22, 2015, p. 2.

See Hannoun, (2015), Ibid. pp. 2–5. Low interest rates boost asset prices by reducing the discount rate on cash flows from assets and raises expectations of improved economic conditions and consequently higher future revenues from those assets. It will further drive investors out of bonds into riskier assets (portfolio rebalancing) and leads over time to a convergence between the returns of risky assets and those of low-risk assets. That implies some level of interest rate risk which is not covered by any sort of regulation as it has always been hidden in the shadows of monetary policy and macroprudential (and more recently microprudential) oversight. That has led to remarkable situations. Prior to the financial crisis, an investor could make a profit either on bonds or equities, but seldom on both simultaneously. That is due to the traditional negative correlation between equities and bonds. But since a few years, that negative correlation does no longer seem to apply in many parts of the world. For the first time in history, declining bond returns go hand in hand with equity price growth. The conclusion is that ‘global monetary policy promotes unbalanced price formation’, see DNB, (2015), Monetary Policy Puts Financial Markets on a Different Track, DNBulletin, April 23. The reflation channel (lifting inflation to central bank targets) mainly aim to avoid deflationary spirals and fuel investments. In terms of the exchange rate channel ‘a depreciation can boost net exports, and hence growth and employment, while lifting inflation through higher import prices’ (p. 5). Problem is often the reciprocity.

Hannoun, (2015), Ibid. pp. 6–9.

M Shirakawa, (2015), Debate on Deflation and the Role of ‘Nominal Anchor’, presentation at the Federal Reserve Bank of Minneapolis Inflation Expectations Symposium, March 30.

H.S. Shin, (2015), Macroprudential Tools, their Limits and their Connection with Monetary Policy, Panel remarks at IMF Spring Meeting event: “Rethinking macro policy III: progress or confusion?” April 15, 2015, Washington, DC, p. 1.

V. Bruno, et al., (2015), Comparative Assessment of Macroprudential Policies, BIS Working Papers, BIS Working Papers Nr. 502, June. See also IMF, (2013), The Interaction of Monetary and Macroprudential Policies, Washington. See also E. Cerutti, et al., (2015), Macroprudential Policies: analysing a New Database, paper presented at the DNB-EBC conference on ‘Macroprudential regulation: from theory to implementation’ on January 29–30, 2015, Amsterdam; K. Kuttner and I. Shim, (2013), Can Non-Interest Rate Policies Stabilise Housing Markets? Evidence From a Panel of 57 Economies, BIS Working Papers, Nr. 433, November 2013; and O. Akinci and J. Olmstead-Rumsey, (2015), How Effective are Macroprudential Policies? An Empirical Investigation, Working paper.

H. S. Shin, (2015), Ibid. p. 3.

See in detail: C. Berio, (2014), The International Monetary and Financial System: Its Achilles Heel and What to Do About It, BIS Working Paper Nr. 456, August, Basel, Switzerland.

C. Berio, (2015), The International Monetary and Financial System: Its Achilles Heel and what to do About It, Institute for New Economic Thinking (INET), ‘2015 Annual Conference: Liberté, Égalité, Fragilité’ Paris, April 8–11, 2015, p. 2. See also on the sources of ‘excess elasticity’ (pp. 3–15).

See in detail: T. Ahnert and C. Bertsch, (2015), A Wake-Up-call Theory of Contagion, Bank of Canada/Banque de France Working Paper Nr. 2015-14, April.

See, for example, related to US Treasury auctions: N. Boyarchenko et al., (2015), Intermediaries as Information Aggregators: An Application to U.S. Treasury Auctions, Federal Reserve Bank of New York Staff Reports, Nr. 726, April.

N. Boyarchenko et al., (2015), Intermediaries as Information Aggregators: An Application to U.S. Treasury Auctions, Federal Reserve Bank of New York Staff Reports, Nr. 726, April, p. 30.

N. Boyarchenko et al., (2015), Intermediaries as Information Aggregators: An Application to U.S. Treasury Auctions, Federal Reserve Bank of New York Staff Reports, Nr. 726, April, p. 1.

J.V. Duca, (2014a), What Drives the Shadow Banking System in the Short and the Long Run, Reserve Bank of Dallas, Working Paper Nr. 1401, February. See also J.V. Duca, (2014b), How Capital Regulation and Other Factors Drive Shadow banking in the Short and Long Run, Working Paper, April.

See for an overview of the literature Duca, (2014a), Ibid. pp. 2–6.

Duca, (2014a), Ibid. p. 6.

See also M.K. Brunnermeier, and Y. Sannikov, (2014), The I Theory of Money, manuscript, Princeton University, April; M.L. Fein, (2013), The Shadow Banking Charade, Working Paper, February 15.

T. Adrian and H.S. Shin, (2009), The Shadow Banking System: Implications for Financial Regulation, Federal Reserve Bank of New York Staff Reports, Nr. 382, July.

Ibid. p. 14.

Ibid. p. 14.

E. Liikannen et al., (2012), High-level expert group on reforming the structure of the EU banking sector, final report, Brussels.

Liikannen et al., (2012), Ibid. p. vi.

J.-A. Verlaine and B. Jennen, (2015), Bank Separation May Face Higher Hurdles in EU Lawmakers’ Deal, BloombergBusiness, October 29, via Bloomberg.​com

EU (2012), Green Paper on Shadow Banking, COM(2012) 102 final, March 19, 2012, and frequently asked questions March 19, 2012 via ec.​europe.​eu.

FSB, (2011), Shadow Banking: Strengthening Oversight and Regulation Recommendations of the Financial Stability Board, Basel, October 27.

Directive 2009/111/EC of the European Parliament and of the Council of September 16, 2009, amending Directives 2006/48/EC, 2006/49/EC and 2007/64/EC as regards banks affiliated to central institutions, certain own funds items, large exposures, supervisory arrangements and crisis management, O.J. L 302, 17.11.2009, pp. 97–119.

Directive 2010/76/EU of the European Parliament and of the Council of November 24, 2010, amending Directives 2006/48/EC and 2006/49/EC as regards capital requirements for the trading book and for re-securitizations, and the supervisory review of remuneration policies, OJ L 329, 14.12.2010, pp. 3–35.

See Annex V, point 8 of Directive 2006/48/EC as amended by Directive 2009/111/EC.

Commission Regulation (EU) No 1205/2011 of November 22, 2011, amending Regulation (EC) No 1126/2008 adopting certain international accounting standards in accordance with Regulation (EC) No 1606/2002 of the European Parliament and of the Council as regards International Financial Reporting Standard (IFRS) 7 Text with EEA relevance.

Directive 2009/138/EC of the European Parliament and of the Council of November 25, 2009, on the taking-up and pursuit of the business of Insurance and Reinsurance, OJ L335/1 of 17.12.2009. The new Solvency II Directive—a recast of several directives—is applicable from January 1, 2016.

Proposal for a Directive of the European Parliament and of the council amending Directives 2003/71/EC and 2009/138/EC in respect of the powers of the European Insurance and Occupational Pensions Authority and the European Securities and Markets Authority.

Directive 2013/36/EU of the European Parliament and of the Council of June 26, 2013, on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, O.J. L 176, 27.06.2013, pp. 338–436.

Regulation (EU) No 575/2013 of the European Parliament and of the council of June 26, 2013, on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, O.J. L 176, 27.6.2013, pp. 1–337.

Corrigendum to Regulation (EU) Nr. 575/2013 of the European Parliament and of the Council of June 26, 2013, on prudential requirements for credit institutions and investment firms and amending Regulation (EU) No 648/2012, O.J. L 208, 2.8.2013, pp. 68–72. Corrigendum to Directive 2013/36/EU of the European Parliament and of the Council of June 26, 2013, on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, amending Directive 2002/87/EC and repealing Directives 2006/48/EC and 2006/49/EC, O.J. L 208,2.8.2013, p. 73.

All documents related to Basel III are available at: http://​www.​bis.​org/​bcbs/​basel3.​htm

See in detail: EU, (2013), Capital Requirements- CRD IV/CRR- Frequently Asked Questions, MEMO, July 16 via ec.​europe.​eu.

Directive 2004/39/EC of the European Parliament and of the Council of April 21, 2004, on markets in financial instruments, O.J. L 145, 30.4.2004, pp. 1–44.

Proposal for a directive of the European Parliament and of the Council on markets in financial instruments repealing Directive 2004/39/EC of the European Parliament and of the Council (Recast) COM(2011) 656 final. Proposal for a Regulation of the European Parliament and of the council on markets in financial instruments and amending Regulation [EMIR] on OTC derivatives, central counterparties and trade repositories; COM(2011) 652 final. Directive 2014/65/EU of the European Parliament and of the Council of May 15, 2014, on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU.

Directive 2014/65/EU of the European Parliament and of the Council of May 15, 2014, on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU, O.J. L 173, 12.6.2014, pp. 349–496 and Regulation (EU) No 600/2014 of the European Parliament and of the Council of May 15, 2014, on markets in financial instruments and amending Regulation (EU) No 648/2012, O.J. L 173, 12.6.2014, pp. 84–148. The MiFID II regulation has been ondergoing multiple correction and amendments in 2014 and 2016. For details see: ec.​europe.​eu.

See also: EC, (2014), Market in Financial Instruments Directive (NiFID II): FAQs, MEMO 14/305, April 15, via ec.​europe.​eu.

Anno 2020 that is still the case and no generic third country framework is in place. Consultations are however ongoing at the level of ESMA (Q1/2020).

Directive 2011/61/EC of the European Parliament and of the Council of June 8, 2011, on Alternative

Investment Fund Managers and amending Directives 2003/41/EC and 2009/65/EC and Regulations (EC) No 1060/2009 and (EU) No 1095/2010, OJ L 174, 1.7.2011, p. 1.

Directive 2009/65/EC of the European Parliament and of the Council of July 13, 2009, on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities.

In July 2011 (2011/273) Q&A on money market funds: http://​www.​esma.​europa.​eu/​system/​files/​ESMA_​273.​pdf and in February 2012 (2012/ 113) Q&A on money market funds http://​www.​esma.​europa.​eu/​system/​files/​2012-113.​pdf, the ES MA en EBA continue to produce guidelines on MMFs and AIFs on a wide variety of topics (stress testing, competent authority principles, reporting requirements …) all the way into 2020. See: esma.​europe.​eu and eba.​europe.​eu.

Regulation (EC) No 1060/2009 of the European Parliament and of the Council of September 16, 2009, on credit rating agencies, O.J. L 302, 17.11.2009, pp. 1–31, and Regulation (EU) No 513/2011 of the European Parliament and of the Council of May 11, 2011, amending Regulation (EC) No 1060/2009 on credit rating agencies, O.J. L 145, 31.5.2011, pp. 30–56.

Regulation (EU) No 462/2013 of the European Parliament and of the council of May 21, 2013, amending Regulation (EC) No 1060/2009 on credit rating agencies. O.J. L 146 of 31.5.2013, pp. 1–33. Directive 2013/14/EU of the European Parliament and of the Council of May 21, 2013, amending Directive 2003/41/EC on the activities and supervision of institutions for occupational retirement provision, Directive 2009/65/EC on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS) and Directive 2011/61/EU on Alternative Investment Funds Managers in respect of over-reliance on credit ratings. O.J. L145 of 31.5.2013, pp. 1–3.

L. Boltanski and L. Thévenot, (2006), On Justification: Economies of Worth, Princeton University Press, Princeton NJ.

See T. Adrian and A.B. Ashcraft, (2012), Shadow Banking: A Review of the Literature. Palgrave Dictionary of Economics; T. Adrian et al., (2013), Shadow Bank Monitoring, Oxford Handbook of Banking, Oxford University, Press, Oxford.

See for a review of those steps: Z. Pozsar et al., (2013), Shadow Banking, Federal Reserve Bank of New York Economic Policy Review Vol. 19, Issue 2, pp. 1–16.

T. Adrian, (2014), Financial Stability Policies for Shadow Banking, Federal Reserve Bank of NY Staff Reports Nr. 664, February, pp. 3 ff.

J. Alworth and G. Arachi, (2012), Taxation and the Financial Crisis, Oxford University Press, Oxford; de Mooij R., et al., (2013), Taxation, Bank Leverage, and Financial Crises, IMF Working Paper Nr. WP/13/48; E.P. Davis and M. Stone, (2004), Corporate Structure and Financial Stability, IMF Working Paper Nr. WP/04/124.

See in detail: N. Gennaioli et al., (2012), Neglected Risks, Financial Innovation, and Financial Fragility, Journal of Financial Economics Vol. 104, Issue 3, pp. 452–468; N. Gennaioli, et al., (2013), A Model of Shadow Banking, Journal of Finance Vol. 68, Issue 4, pp. 1331–1363; A. Ashcraft et al., (2011), Credit Ratings and Security Prices in the Subprime MBS Market, American Economic Review Vol. 101, Issue 3, pp. 115–119; J. Coval, et al., (2009), The Economics of Structured Finance, Journal of Economic Perspectives Vol. 23, Issue 1, pp. 3–25.

T. Adrian, (2014), Ibid. p. 5.

T. Adrian, (2014), Ibid. pp. 12–20. His case studies involve agency mortgage REITs (Agency mortgage REITs (agency REITs) are specialized REITs that invest in mortgage backed securities (MBS) issued by US government-sponsored agencies), leveraged lending and captive reinsurance.

Supervisory rule 13-3, Interagency Guidance on Leveraged Lending, March 21, 2013 (revised November 13, 2014).

See, for example, R.S.J. Koijen and M. Yogo, (2014), Shadow Insurance, Swiss Finance Institute Research Paper Nr. 14–64; The issue was brought to mind first by B. M. Lawsky of the NY Department for Financial Services indicating that the loopholes in the shadow insurance sector might embed material risks for the public markets and the Treasury: see B.J. Lawsky, (2013), Shining a Light on Shadow Insurance, A Little-known Loophole That Puts Insurance Policyholders and Taxpayers at Greater Risk, New York State Department of Financial Services Working Paper, June.

An exception to that is the junior and distressed investors in the market who ‘effectively’ anticipate on a possible default by their counterparties.

I ignore the discussion about the credit rating debate and their involvement in providing inadequate ratings to securitized products. It is not part of the shadow banking discussion, although materially important.

N. Gennaioli et al., (2013), Ibid. p. 1332.

G. Brown, (2010), Beyond the Crash: Overcoming the First Crisis of Globalization, Free Press, New York.

N. Gennaioli et al., (2013), Ibid. p. 1332.

See, for example, how CDS (‘credit default swap’) are experiencing their renaissance in recent years and what drives that market; T. Alloway, (2015), Why Would Anyone Want to Restart the Credit Default Swaps Market? Saving Single-Name Credit Default Swaps?, Bloomberg.​com, May 11.

See, for example, T. V. Dang, et al., (2009), Ignorance and the Optimality of Debt for Liquidity Provision, Working Paper, Yale University.

See Gennaiola et al., (2013), Ibid. p. 1357; see also V.V. Acharya, et al. (eds.), (2009), Restoring Financial Stability: How to Repair a Failed System, John Wiley & Sons, Inc., Hoboken, NJ.

The fact that informed investors refuse to roll over debt more than uninformed investors exacerbates the probability of a debt crisis; see, for example, T. Ahnert and A. Kakhbod, (2014), Information Choice and Amplification of Financial Crises, Working Paper: ‘a slight deterioration in the public information about a debtor’s solvency can increase an investor’s strategic uncertainty’.

J.C. F. Kuong, (2014), Fragility of Collateralized Short-Term Debt Markets, INSEAD Working Paper, July. He also indicates that lifting an exception on the automatic stay in repo finance and for derivatives can worsen the moral hazard of borrowers and lead to more fire sales.

C.-H. Weymuller, (2013), Leverage and Reputational Fragility in Credit Markets, HBS Working Paper, January.

N. Gennaioli et al., (2013), Ibid. pp. 1359–1360.

G. Gorton and A. Metrick, (2010), Regulating the Shadow Banking System, Yale and NBER Working Paper, October, pp. 12–14.

G. Gorton and A. Metrick, (2010), Ibid. pp. 15–16.

As suggested by the FSB: see FSB, (2014), Regulatory Framework for Haircuts on Non-Centrally Cleared Securities Financing Transactions, Basel, October 14.

G. Gorton and A. Metrick, (2010), Ibid. p. 26.

T. Adrian et al., (2014) Financial Stability Monitoring, Federal Reserve Bank of New York Staff Reports, Nr. 601.

T. Adrian et al., (2014), Ibid. p. 2.

See their empirical analysis regarding cyclical financial vulnerabilities in the shadow banking segment: T. Adrian, et al., (2013), Ibid. pp. 16–21.

See, for example, T. Adrian, and N. Boyarchencko, (2012), Intermediary Leverage Cycles and Financial Stability, FRB of New York Staff Report Nr. 567 and M. Gertler, and N. Kiyotaki, (2012), Banking, Liquidity, and Bank Runs in an Infinite Horizon Economy, Princeton University Working Paper.

T. Adrian et al., (2014), Ibid. pp. 2–5.

The latter however is still not empirically tested (to my knowledge).

T. Adrian et al., (2014), Ibid. p. 6.

A. Admati, and Martin Hellwig, (2013), The Bankers’ New Clothes: What’s Wrong with Banking and what to Do about it, Princeton University Press, Princeton NJ; A. Admati, et al., (2010), Fallacies, Irrelevant Facts, and Myths in the Discussion of Capital Regulation: Why bank Equity is Not Expensive, Stanford University Working Paper. Let’s say that in a competitive banking market, higher equity buffers will lead to lower ‘return on equity’ which is what drives the argument against higher capital buffers. But equity is just another source of funding that can be used to provide credit with into the market.

See the Pigovian chapter and also J. Bianchi, and E. Mendoza, (2011), Over-borrowing, Financial Crises and Macroprudential Policy, IMF Working Paper Nr. WP/11/24.

See, for example, in the housing market: L. Lambertini et al., (2012), Leaning against Boom-Bust Cycles in Credit and Housing Prices, Working Paper. They conclude ‘responding to financial variables is socially optimal’ and ‘responding to credit growth is Pareto improving’ and also ‘[b]orrowers are better off when both the LTV (Loan-to-Value) ratio and the interest rate respond to credit growth, which most effectively Stabilizes credit relative to GDP. Savers are better off under an interest rate response to credit growth coupled with a constant LTV ratio’. See also regarding the impact whether loose monetary policies increase financial stability: A. Cesa-Bianchi and A. Rebucci, (2013), Does Easing Monetary Policy Increase Financial Instability, Inter-American Development Bank Working Paper, Nr. IDB-WP-387, February. They indicate ‘when the policy interest rate is the only available instrument, a monetary authority subject to the same constraints as private agents cannot always achieve a (constrained) efficient allocation and faces a trade-off between macroeconomic and financial stability in response to negative shocks’.

See in detail: T. Adrian et al., (2014), Ibid. pp. 16–21.

T. Adrian and A.B. Ashcraft, (2012), Shadow Banking Regulation, Federal Reserve Bank of NY, Staff Reports, Nr. 559, April. See for a review: pp. 26–38.

T. Adrian and A.B. Ashcraft, (2012), Shadow Banking Regulation, Federal Reserve Bank of NY, Staff Reports, Nr. 559, April, p. 2.

T. Adrian and A.B. Ashcraft, (2012), Ibid. pp. 3–4.

T. Adrian and A.B. Ashcraft, (2012), Ibid. p. 8.

T. Adrian and A.B. Ashcraft, (2012), Ibid. pp. 8–9.

T. Adrian and A.B. Ashcraft, (2012), Ibid. pp. 10–15 & 23–26.

T. Adrian and A.B. Ashcraft, (2012), Ibid. pp. 15–20.

T. Adrian and A.B. Ashcraft, (2012), Ibid. pp. 20–23.

T. Adrian and A.B. Ashcraft, (2012), Ibid. pp. 38–53 for an evaluation of actual legislation versus the economic frictions identified.

See, for example, for an evaluation: F. Wendt, (2015), Central Counterparties: Addressing their Too Important to Fail Nature, IMF Working Paper Nr. WP/15/21.

Measurements vary but stand mid 2019 at about approx. 1000 trillion USD.

F. Wendt, (2015), Ibid. pp. 22. See for an evaluation of current legislation that addresses CCPs’ systemic risk: pp. 14–18. See also A.J. Menkveld, (2014), Crowded Trades: An Overlooked Systemic Risk for Central Clearing Counterparties, Working Paper. See for an industry perspective: Joint letter to J. Lew, (2015), U.S. Regulatory Oversight of Central Counterparties, March 9. See for a risk assessment overview: FIA, (2015), FIA Global CCP Risk Position Paper, April. Also the CCP dedicated chapter (5).

See for an overview: BIS-IOSCO, (2015), Public Quantitative Disclosure Standards for Central Counterparties, February, Basel. A good example of how regulators and supervisors know the issues but have a difficulty breaking down into granular concepts that have a chance of being tackled by regulation: Bank of England, (2015), The Bank of England’s Supervision of Financial Market Infrastructures—Annual Report, March.

The ISDA suggested a framework for those plans; see ISDA, (2015), CCP Default Management, Recovery and Continuity: A Proposed Recovery Framework, January.

T. Adrian and A.B. Ashcraft, (2012), Ibid. p. 53.

See also for an evaluation of the implications of the Dodd-Frank Act in this context: T. Adrian, (2011), Dodd-Frank One Year On: Implications for Shadow Banking, Federal Reserve Bank of New York Staff Reports, Nr. 533, December.

How that can be achieved is up for discussion: either one forces the system for short-term debt to be fully backed by AAA-securities as Wolf (M. Wolf, (2014), The Shifts and the Shocks: What We’ve Learned-and Have Still to Learn-from the Financial Crisis, Penguin Books, New York) suggests and/or one considers a Pigovian mechanism as I suggested in the Pigovian chapter that would ex ante neutralize the possible externalities caused by the intermediation process. See for an application of the maturity transformation model in a highly unstable market: A. Krishnamurthy et al., (2014), Seizing Up Repo, The Journal of Finance, Vol. 69, Issue 6 (December), pp. 2381–241.

Keeping Minsky in mind: ‘[f]inancial crises take place because economic units need or desire more cash than is available from their usual sources and so they resort to unusual ways to raise cash’, see H. P. Minsky, (1982), Can “It” Happen Again? Essays on Instability and Finance, M. E. Sharpe Armonk, NY.

The inability of OPEC to coordinate their actions over time is a small-scale example of network inefficiencies and demonstrates larger individual gains than collective detriments in case one of the parties (in this case countries) sidesteps collective agreements or directions agreed upon.

‘The opacity issue should be addressed at its core, i.e. on the level of incentives: when markets are unable to value a security or a structured product, financial intermediaries are in position to take advantage of other market participants’.

W. Kalinowski, (2012), Shadow Banking and the Moral Hazard. Principles for Reducing Model-Based Opacity in Securities Finance, Veblen Institute for Economic Reforms, Paris, p. 2.

See for an example the repo and securities lending market: T. Adrian et al., (2013), Repo and Securities Lending, Federal Reserve Bank of New York Staff Reports, Nr. 529, February (revised). Specifically, they argue that, at a minimum, six shared characteristics of repo and sec lending trades would need to be collected at the firm level: (1) principal amount, (2) interest rate (or lending fee for certain securities loan transactions), (3) collateral type, (4) haircut, (5) tenor and (6) counterparty.

P. Volcker, (2009), Think More Boldly, The Wall Street Journal web edition, December 14.

W. Kalinowski, (2012), Ibid. pp. 3 & 12. He suggests ‘[t]hese questions lead to three simple principles for an effective regulatory response: radical disclosure beyond what is currently required by international accounting standards (IFRS) and its US equivalent (GAAP), shifted burden of proof as for who is charged to prove how models actually work; and precaution in matter of financial innovation’.

In this case, that collateral damage lies particularly in the impact of a higher cost of funding for the real economy and the liquidity available to flow through to the real economy. The credit intermediation process would also have to be reviewed and right-weighting abolished.

See for parallel evaluations: J. Benes and M. Kumhof, (2012), The Chicago Plan Revisited, IMF Working Paper Nr. WP/12/202 and a twenty-first-century evaluation: L. Kotlikoff, (2010), Jimmy Stewart is Dead, Ending the World’s Ongoing Financial Plague with Limited Purpose Banking, Wiley & Sons, Hoboken.

K. Rogoff, (2014), The Shifts and the Shocks: What we’ve learned – and have yet to learn – from the financial crisis, by Martin Wolf, A Review, by Kenneth Rogoff, Harvard University Prospect Magazine, August 20.

K. Rogoff, (2014), Ibid.

See J.K. Galbraith, (2009), Who Are These Economists, Anyway?, Fall, Though & Action, pp. 85–97.

See J.K. Galbraith, (2009), Ibid. p. 92.

W. Kalinowski, (2012), Ibid. p. 8.

W. Kalinowski, (2012), Ibid. p. 11.

W. Kalinowski, (2012), Ibid. p. 12.

J.-L. Arcand et al., (2012), Too Much Finance?, IMF Working Paper Nr. WP/12/161.

B. J. Noeth and R. Sengupta, (2011), Is Shadow Banking Really Banking, The Regional Economist, St. Louis Fed, pp. 8–13.

J. Huang, (2015), Ibid. pp. 2–3.

J. Huang, (2015), Ibid. p. 3.

J. Huang, (2015), Ibid. pp. 4–5.

J. Huang, (2015), Ibid. p. 5.

See for an overview: T. Adrian, and A. B Ashcraft, (2012), Shadow Banking: A Review of the Literature, Technical report, Federal Reserve Bank of New York.

See for literature references of the different strands: J. Huang, (2015), Ibid. pp. 5–6.

J. Huang, (2015), Ibid. p. 29.

J. Huang, (2015), Ibid. p. 30.

J. Huang, (2015), Ibid. p. 31. That has distinct welfare and policy implications; see for a review Huang, (2015), Ibid. pp. 31–38.

See in extenso: T. Adrian and N. Liang, (2014), Monetary Policy, Financial Conditions, and Financial Stability, Federal Reserve Bank of New York Staff Reports, Nr. 690, September. For the shadow banking specifics, see pp. 9–12. See also R. Berner, (2014), Financial Stability: Progress and Challenges, Working Paper.

See in an EU context: EC, (2015), Commission Staff Working Document, European Financial Stability and Integration Review, April 2015, pp. 62–86.

See also M. Holopainen, and P. Sarlin, (2015), Toward Robust Early-Warning Models: A Horse Race, Ensembles and Model Uncertainty. Bank of Finland Discussion Paper Nt. 06/2015; J.H. Lang, et al., (2018), A Framework for Early Warning Modelling, ECB Working Paper Nr. 2182, October.

See in detail: F.X. Diebold, and K. Yilmaz, (2014), On the Network Topology of Variance Decompositions: Measuring the Connectedness of Financial Firms, Journal of Econometrics Vol. 18, Issue 1, pp. 119–134; P. Sarlin, and T. Peltonen, (2013), Mapping the State of Financial Stability, Journal of International Financial Markets, Institutions & Money Vol. 26, pp. 46–76; P. Sarlin, (2014), Macroprudential Oversight, Risk Communication and Visualization, lSE SP Working Paper Nr. 4.

See also (for other models): L. Alessi, and C. Detken, (2011), Quasi Real Time Early Warning Indicators for Costly Asset Price Boom/Bust Cycles: A Role for Global Liquidity. European Journal of Political Economy, Vol. 27, Issue 3, pp. 520–533; K. Anand, et al., (2014), Filling in the Blanks: Network Structure and Interbank Contagion, Nr. 02/2014, Discussion Paper, Deutsche Bundesbank. J. Babecky, et al., (2014), Banking, Debt, and Currency Crises: Early Warning Indicators for Developed Countries, Journal of Financial Stability Vol. 15, pp. 1–17; F. Betz, et al., (2014), Predicting Distress in European Banks, Journal of Banking & Finance Vol. 45, pp. 225–241; M. Billio, et al., (2012), Econometric Measures of Connectedness and systemic risk in the Finance and insurance sectors, Journal of Financial Economics Vol. 104, Issue 3, pp. 535–559; O. Castrén, et al., (2014), Macro-networks: An Application to Euro Area Financial accounts, Journal of Banking & Finance Vol. 46, pp. 43–58; E. Cerutti, et al. (2014), Global Liquidity and Drivers of Cross-Border Bank Flows, IMF Working Paper Nr. WP/14/69; M. Chinazzi, et al., (2013), Post-Mortem Examination of the International Financial Network, Journal of Economic Dynamics and Control, Nr. 37, Issue 8, pp. 1692–1713; M. Lo Duca, et al., (2013), Assessing Systemic Risks and Predicting Systemic Events, Journal of Banking & Finance, Vol. 37, Issue 7, pp. 2183–2195; C. Minoiu, et al., (2013), Does Financial Connectedness Predict Crises? International Monetary Fund Working Paper Nr. WP/13/267 and C. Minoiu, et al., (2013), A Network Analysis of Global Banking: 1978–2010, Journal of Financial Stability, Vol. 9, Issue 2, pp. 168–184.

See, for example, recently P. H. Kupiec et al., (2015), Does Bank Supervision Impact Bank Loan Growth, American Enterprise Institute, AEI Economic Policy Working Paper Nr. 2015-07, May 11, with further reference to other literature on the matter.

P. Bongini et al., (2014), Curbing the Moral Hazard of a SIFI: a Mission Impossible?, September.

See for other research pointing in the same direction: Abreu J. F. and M.A. Gulamhussen, (2013), The Stock Market Reaction to the Public Announcement of a Supranational List of Too-Big-to-Fail Banks during the Financial Crisis, Journal of International Financial Markets, Institutions & Money, Vol. 25, pp. 49–72; P. Bongini et al., (2014), The Importance Of Being Systemically Important Institutions, Journal of Banking and Finance; K. Ueda and B. Weder Di Mauro, (2012), Quantifying Structural Subsidy Values For Systemically Important Financial Institutions, Journal of Banking and Finance, Vol. 37, pp. 3830–3842.

J. den Hartog, (2010), Review of Economic Theories, Tjalling C. Koopmans Research Institute, Discussion Paper Series Nr. 10–18. Observed the extended literature list at pp. 47–59.

J. Temesvary, (2015), The Role of Regulatory Arbitrage in US Banks’ International Flows: Bank-Level Evidence, Working Paper, May (in 2018 published in Economic Inquiry, Vol. 56, Issue 4, October, pp. 2077–2098).

See also M. Gulamhussanw, et al., (2014), International Diversification and Risk of Multinational Banks: Evidence From the Pre-Crisis Period, Journal of Financial Stability Vol. 13, pp. 30–43; H. Hoque, et al., (2015), Bank Regulation, Risk and Return: Evidence From the Credit and Sovereign Debt Crises, Journal of Banking & Finance Vol. 50, pp. 455–474; E. Cubillas, and F. Gonzalez, (2014), Financial Liberalization and Bank Risk-Taking: International Evidence, Journal of Financial Stability Vol. 11, pp. 32–48; I. Agur, (2013), Multiple Bank Regulators and Risk Taking, Journal of Financial Stability Vol. 9, pp. 259–268.

Temesvary, (2015), Ibid. p. 3.

Temesvary, (2015), Ibid. p. 3.

Temesvary, (2015), Ibid. p. 20.